Meeting of the Federal Open Market Committee December 19, 2000 A meeting of the Federal Open Market Committee was held in the offices of the Board of Governors of the Federal Reserve System in Washington, D.C., on Tuesday, December 19, 2000 at 9:00 a.m. PRESENT: Mr. Greenspan, Chairman Mr. McDonough, Vice Chairman Mr. Broaddus Mr. Ferguson Mr. Gramlich Mr. Guynn Mr. Jordan Mr. Kelley Mr. Meyer Mr. Parry Mr. Hoenig, Ms. Minehan, Messrs. Moskow and Poole, Alternate Members of the Federal Open Market Committee Messrs. McTeer, Stern, and Santomero, Presidents of the Federal Reserve Banks of Dallas, Minneapolis, and Philadelphia respectively Mr. Kohn, Secretary and Economist Mr. Bernard, Deputy Secretary Mr. Gillum, Assistant Secretary Ms. Fox, Assistant Secretary Mr. Mattingly, General Counsel Mr. Baxter, Deputy General Counsel Ms. Johnson, Economist Mr. Stockton, Economist Mr. Beebe, Ms. Cumming, Messrs. Goodfriend, Howard, Lindsey, Reinhart, Simpson, and Sniderman, Associate Economists Mr. Fisher, Manager, System Open Market Account Messrs. Madigan and Slifman, Associate Directors, Divisions of Monetary Affairs and Research and Statistics respectively, Board of Governors 2 Mr. Winn, Assistant to the Board, Office of Board Members, Board of Governors Mr. Ettin, Deputy Director, Division of Research and Statistics, Board of Governors Messrs. Oliner, and Struckmeyer, Associate Directors, Division of Research and Statistics, Board of Governors Mr. Whitesell, Assistant Director, Division of Monetary Affairs, Board of Governors Ms. Low, Open Market Secretariat Assistant, Division of Monetary Affairs, Board of Governors Mr. Lyon, First Vice President, Federal Reserve Bank of Minneapolis Ms. Browne, Messrs. Hakkio, Hunter, Kos, Ms. Mester, Messrs. Rolnick and Rosenblum, Senior Vice Presidents, Federal Reserve Banks of Boston, Kansas City, Chicago, New York, Philadelphia, Minneapolis, and Dallas respectively Messrs. Cunningham and Gavin, Vice Presidents, Federal Reserve Banks of Atlanta and St. Louis respectively 3 Transcript of Federal Open Market Committee Meeting of December 19, 2000 CHAIRMAN GREENSPAN. Would somebody like to move approval of the minutes for the November 15th meeting? VICE CHAIRMAN MCDONOUGH. So move. SPEAKER(?). Second. CHAIRMAN GREENSPAN. Peter Fisher. MR. FISHER. Thank you, Mr. Chairman. I’ll be referring to a package of charts with a peach or salmon cover that should be in front of you.1 The first page depicts deposit rates on forward contracts. U.S. current and forward rates have moved lower since the last FOMC meeting, most noticeably in a series of steps. The first such step was on November 28th, following the release of the durable goods data; the next was on December 5th, following Chairman Greenspan's speech to the Community Bankers group; and rates moved down again at the end of last week following the release of the PPI and CPI. The current 3-month rate is now less than 5 basis points over the Committee's target fed funds rate, and the 9-month forward 3-month rate is now 85 basis points under the current 3-month rate. Euro deposit rates have also moved lower since your last meeting, following roughly the same pattern and timing as the declines in dollar rates. In addition to moving down after the release of the durable goods orders data and after the Chairman's speech on Friday, December 5th, they also fell last week. The latter move was in conjunction not only with the release of the CPI but also the report of the sixth consecutive monthly decline in the German IFO survey of business confidence. While the differentials have narrowed somewhat because of the larger declines in the dollar, they remain rather considerably in the dollar's favor. The differential in the current 3-month rate is still 160 basis points. In the 3-month and 9-month forward rates the differentials are 125 basis points and more than 100 basis points, respectively. As for Japan, deteriorating sentiment about the Japanese economy is not obviously reflected in the forward rates shown in the bottom 1 A copy of the charts used by Mr. Fisher is appended to this transcript (Appendix 1) 4 panel, which at first glance appear to be treading water. However, I think the convergence of the 3-month forward and the 9-month forward rates in the last few weeks does reflect an unwinding of the modest hopes for an accelerating economy over the next year. The current 3- month yen deposit rate has ticked up on funding pressures, reflecting the combination of the Bank of Japan's new payments system--launched at the beginning of the year--and the normal fiscal year-end financing requirements associated with the first calendar quarter, which is their last fiscal quarter. In the top panel of the next page you can see movements in the U.S. Treasury yield curve, with the 2-year note in red, the 10-year note in blue, and the 30-year bond in green. These yields have moved down in roughly the same pattern as the forward rates, with the rate on 2- and 10- year notes having come down by just less than 60 basis points each since your last meeting. In the bottom panel I've depicted the differential between dollar and euro swap rates--the 2-year differential in red and the 10-year in blue. The dramatic narrowing of the latter since the Chairman's speech to the Community Bankers has been explained as reflecting expectations of a more pronounced slowing in the U.S. economy as compared with Europe. While that perception is around, focusing on the 10-year sector seems to me to overstate the change in the relative outlooks. If there had been a sharp divergence in growth expectations, one might have expected to see a bit more of it reflected in the 2-year rates. While the 2- year differential has narrowed by about 20 basis points since your last meeting, that is considerably less than the narrowing of 46 basis point in the 10-year differential. The explanation I have been offered by market participants is that the pronounced fall in 10-year swap rates reflects the needs of those who manage mortgage portfolios and have to extend their portfolio's duration as interest rates decline in order to hedge prepayment risks. And with thinning Treasury markets, these portfolio managers increasingly look to agency securities and the swap market as additional sources of liquidity to complete their hedging. In effect, the more pronounced narrowing of the 10-year swap differential reflects the greater extent to which the agency financing of the housing stock is marked to market on a daily basis here in North America as compared with Europe. Two-year rates may yet prove to be a lagging indicator, or the short end of our yield curve may yet decline by more than the market now expects. But as long as the 2-year differential remains over 100 basis points in the dollar's favor, it is hard for me to think that market participants are expecting markedly diverging growth paths for Europe and North America. 5 On page 3 I've provided a set of charts on yield curves similar to the charts I showed you at the last meeting, this time with addition of the BB1 industrial corporate index. At the upper left is the yield curve as of May 16th, the day the Committee last raised rates. The upper right panel shows yields just after your November 15th meeting. The lower left panel is for November 28th, after the release of the durable goods orders data, and the lower right one is for December 15th, after the CPI release. Looking from the upper right to the lower right--comparing rates at the end of the day of your last meeting to today--you can see that the U.S. Treasury yield curve has moved noticeably lower. One might say that the 2- to 30-year curve now hovers around the central tendency of 5- 1/2 percent, 100 basis points under the funds rate. The swap curve over that maturity range has been pulled completely below the funds rate. And 2-year A2 industrial corporate paper yields the same as the overnight rate. The BB1 yields have moved appreciably lower, by 50 basis points in the 2-, 5-, and 10-year maturities since the time of your last meeting. Now, with the short ends outperforming the long ends and the better credits outperforming the lesser credits at the long end, what seems to me to be happening is that very different sets of concerns in the markets at the moment are converging in terms of investor behavior. From whatever their different starting points, investors are tending to shorten duration and move into the higher quality credits. Those who expect a pronounced and enduring slowdown of activity expect a considerable easing of monetary policy and thus are positioning themselves to enjoy a rally in the short end of the yield curve. Those who think the current slowdown may only be a pause are concerned about the potential volatility of GDP and thus are tending to reduce their duration in order to minimize their exposure to the long end. Those who are concerned about corporate earnings strains and deteriorating credit quality are fearful of corporate event risks and are reducing the maturity of their credit exposures while shifting into better credits. Those who have finished their risk-taking for the year because they have a sufficiency of either gains or losses, have positioned themselves into the short end while they await next year’s opportunities. As the short end of the curve and the better credits across the curve have rallied, the hedging by mortgage portfolio managers has accelerated the movement down.